Question

According to the capital asset pricing model, in equilibrium, what is the relationship between the expected return of an asset and its beta?

1) The expected return of an asset is directly proportional to its beta.
2) The expected return of an asset is inversely proportional to its beta.
3) The expected return of an asset is unrelated to its beta.
4) The expected return of an asset is equal to its beta.

Answer 1

According to the Capital Asset Pricing Model, the expected return of an asset is directly proportional to its beta.

Step-by-step explanation:

The relationship between the expected return of an asset and its beta, according to the Capital Asset Pricing Model (CAPM), is that the expected return of an asset is directly proportional to its beta. In other words, as the beta of an asset increases, so does its expected return, and vice versa.

Beta is a measure of systematic risk, which represents how sensitive the returns of an asset are to overall market movements. Assets with a higher beta are deemed to have more risk and therefore, investors expect a higher return to compensate for this increased risk. On the other hand, assets with a lower beta are considered less risky, and therefore, investors expect a lower return.